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The Fed’s ‘Explicit Guidance’ Is Full of Loopholes

Brian Chappatta

(Bloomberg Opinion) -- Federal Reserve officials determined at their meeting two months ago that providing greater clarity about the likely future path of the federal funds rate “would be appropriate at some point.”

That moment is now.

The majority of the Federal Open Market Committee saw little reason to wait to debut so-called “enhanced forward guidance,” which more explicitly ties future interest-rate increases to specific economic outcomes. In a statement, the central bank pledged to keep the fed funds rate unchanged in a range of 0% to 0.25% “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” According to the median projection of Fed officials, the unemployment rate won’t fall below the longer-run estimate of 4.1% until 2023, and the core personal consumption expenditures index won’t reach 2% until the same year. That means bond traders should have every reason to think interest rates will remain near zero for at least the next three years.

The move to cement outcome-based forward guidance so soon was something of a surprise. Only 39% of respondents to a Sept. 4-10 Bloomberg poll thought it would happen, while almost a third said they didn’t see such a change coming about until 2021 or later. It’s possible Fed Chair Jerome Powell considered it a necessary next step after his speech last month, which disclosed changes to the central bank’s statement on longer-run goals and monetary policy strategy. Bond traders have had ample time to digest the fact that the Fed will now seek inflation that averages 2% over time, including periods of overshooting the mark to make up for falling short, in what Powell and his colleagues call “flexible average inflation targeting.” The next order of business was following through on that big talk with tangible action.

“These changes clarify our strong commitment on a longer time horizon,” Powell said in his opening statement.

Still, digging a bit deeper reveals the sheer amount of wiggle room that the FOMC afforded itself come 2023, or whenever it might seem appropriate to raise interest rates from near-zero. Again, as the statement is written, there are three conditions:

“Until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment.”

“Inflation has risen to 2 percent.” 

Inflation also “is on track to moderately exceed 2 percent for some time.” 

That last one in particular is extremely vague and seems destined to ignite robust debate both within and outside of the central bank when the U.S. economy has long since recovered from the coronavirus pandemic. Officials can have different opinions on whether inflation is “on track” to exceed 2%. Officials can have different interpretations of “moderately” — is that 2.2%, 2.5% or 3%? Officials can have different assessments of “some time” — is that six months, a year, or two years?

It also comes off a bit at odds with Powell’s message last month that 2% shouldn’t be seen as a ceiling on inflation. This was why Minneapolis Fed President Neel Kashkari dissented. According to the statement, he prefers that the Fed “indicate that it expects to maintain the current target range until core inflation has reached 2 percent on a sustained basis.” Basically, he wants to see actual evidence of inflation at or above 2% before raising rates from near-zero, rather than just saying they’re “on track” to do so and start tightening. Moving the fed funds rate up to 1%, or even 2%, would technically still be “an accommodative stance of monetary policy,” based on the median longer-term target rate of 2.5%.

Powell was asked directly during the question-and-answer portion to explain each of the modifiers in the three-part test for an interest-rate hike. What he said actually suggests even more loopholes than what the statement says:

“Maximum employment is not something that can be reduced to a number the way inflation can. It’s a broad range of factors, it really always has been and really a substantial number of factors we indicated we would look at. It’s broader labor conditions, consistent with our committee’s assessment of maximum employment. So that would certainly mean low unemployment, high labor force participation, it would mean wages, it’s a whole range of things. We’re not looking at a rule, we’re looking at a judgmental assessment, which we’ll be very transparent about as we go forward.”

“In terms of inflation, this is a committee that is both confident and committed and determined to reach our goals. And the idea that we would look for the quickest way out, it’s just not who we are, there’s no message of that here. We would not be looking for one month of 2% inflation. We said to achieve 2% inflation, just to understand that we’re strongly committed to achieving our goals and the overshoot, so that should tell you about that.”

“What does moderate mean? It means not large. It means not very high above 2%, it means moderate. I think that’s a fairly well-understood word. In terms of ‘for a time,’ what it means is not permanently and not for a sustained period. We’re resisting the urge to try to create some sort of a rule or a formula here, and I think the public will understand pretty well of what we want. It’s actually pretty straightforward.”

He ended that with a shoulder shrug.

“That was a great question: Please define all of your terms,” Jeffrey Rosenberg, a senior portfolio manager at BlackRock Inc., said on Bloomberg TV after Powell’s press conference. “Taking away the ambiguity of the Fed’s statement is going to be a hard question to answer, because the Fed needs that ambiguity.”

Bond traders more or less reacted to the Fed decision with a shoulder shrug as well. Shorter-term Treasury yields were little changed, while 30-year yields rose, likely on disappointment that the central bank’s bond-buying program didn’t skew toward purchasing longer-dated debt. The Fed did say it’s buying Treasury securities and agency mortgage-backed securities not just “to sustain smooth market functioning,” as before, but also to “help foster accommodative financial conditions.” Still, the central bank is saving an Operation Twist-style tweak for another time.

The Fed will keep interest rates pinned near zero for years. That much is obvious. But now it’s clear that even with the debut of more explicit forward guidance, when the time comes to consider raising rates, the central bank will have any number of reasons not to do so. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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